Experts predict next Thursday’s Bank of England base rate rise
The last interest rate decision took place on 22 September where the base rate climbed from 1.75% to 2.25% as the MPC looked to curb the effects of the ongoing eyewatering inflation rate.
But that was a day before the disastrous mini Budget which sent shockwaves through the economy because of the multi-billion pound worth of unfunded tax cuts.
It saw the pound fall to a record low against the dollar, mortgage providers pull deals from the market, gilt yields soar and a pension fund sell-off which was tamed only after the Bank of England’s bond-buying programme.
Former Chancellor Kwasi Kwarteng was sacked and replaced with Jeremy Hunt, before Liz Truss resigned as she acknowledged her mandate of growth had backfired after the majority of the tax cuts she was elected to deliver were scrapped.
We now have a new Prime Minister in Rishi Sunak and his appointment has steadied the market turmoil. With the ‘Halloween Budget’ – the Autumn Statement – pushed back from 31 October to 17 November, it appears the government is playing a waiting game to see how the markets fare without any government intervention.
But, the MPC will meet next week to decide the base rate which will be published on Thursday 3 November.
Markets are pricing in a 0.75% increase
For Laith Khalaf, head of investment analysis at AJ Bell, since the reversal of the mini Budget, “the case for additional interest rate rises has diminished, as the Treasury is no longer pushing in the opposite direction to the Bank of England”.
Khalaf said: “Make no mistake, interest rates are going up from here, but the government’s climb down from the inflationary policies of Trussonomics means the Bank won’t have to slam down on the brakes quite as hard.
“The market is now pricing in a 0.75% interest rate rise at the next meeting. The delay to the new Chancellor’s fiscal statement will probably encourage the Bank’s rate-setters to be cautious with their November interest rate hike, because they’ll still be missing a big part of the economic picture. The Bank can always then adjust monetary policy at the December meeting if needed, when the full scope of the government’s fiscal plans will be laid bare by the Autumn Statement.”
Khalaf added: “Looking further out, the trajectory for UK interest rates is quite breathtaking, especially when you consider that at the beginning of last year the Bank of England was warning about the possibility of negative interest rates.
“Last November, the base rate still stood at 0.1%, and the central bank was predicting inflation would peak at 5% in April of this year. Now markets are pricing in base rate hitting 5% in 2023, and CPI inflation sits at a distinctly uncomfortable 10.1%.”
Base rate could rise 100bps to 3.25%
For consultancy Capital Economics, it’s 50/50 whether the base rate will rise by 75bps or 100bps next week.
But it is being bold as on balance, it expects the base rate to rise from the current 2.25% to 3.25% rather than another “hawkish 50bps rise”.
Ruth Gregory, senior UK economist, said the further strengthening in domestic inflationary pressures and exceptional tightness in the labour market suggests there is a strong case for the MPC to opt for an aggressive interest rate hike.
She said there are several convincing reasons for this with the first being that three members of the committee voted to raise rates by 75bps at the September meeting.
“Second, and most importantly, the data released since September appears to have met the Bank of England’s criteria of ‘more persistent inflationary pressures’ required for the MPC to respond ‘forcefully’.
Tight labour market
Gregory explained that the labour market has remained tighter than expected and the rise in wage growth was above the MPC’s earlier forecast.
“Of course, the labour market is a lagging indicator that has yet to reflect in full the most recent easing in economic growth. Even so, this will raise concerns that domestic price pressures will linger for longer.
“There has been evidence too that the price and wage expectations of businesses are still high even as the economic outlook has weakened. Businesses expect to raise their selling prices by 6.7% over the next year, up from 6.4% in August. And businesses intend to raise wages by 5.9% over the next year, up from August’s 5.5%.
“This evidence will have done little to diminish the MPC’s concerns that the continued strength in domestic price pressures will cause a more prolonged period of above-target inflation.
“This suggests the MPC may step up the pace and deliver a big rate hike next Thursday. After all, a surprise 100bps rate hike would have a bigger downward influence on price and wage expectations than two well-telegraphed 50bps hikes,” she said.
Inflation and a weak pound
Gregory added that “the MPC may judge that the costs of not raising rates far enough soon enough are bigger than the costs of raising rates too far too soon and having to cut them again”.
“As those members who voted to raise rates by 75bps in September put it, ‘faster policy tightening now would help to bring inflation back to the target sustainably in the medium term, and reduce the risks of a more extended and costly tightening cycle later’.”
And when looking at other moves by central banks, such as the ECB’s 75bps hike yesterday, this creates another incentive for the Bank to keep pace and prevent the pound from weakening further.
She concluded: “While a wide range of outcomes are possible at next week’s MPC meeting, we think the chances of a 100bps hikes are higher than the market and other forecasters appreciate. The financial markets have priced in a 64% chance of a 75bps hike and a 36% chance of a 100bps hike. That said, a 100bps hike is certainly not nailed on and it is perhaps very close to 50/50 on 75bps versus 100bps.”